Wednesday, August 09, 2006

When the U.S. and EAFE Markets Move Together

A nice measure of how equities outside the U.S. are performing is the EAFE ETF (EFA), which taps into stocks across Europe & Australasia Far East. Normally, EFA correlates highly with the S&P 500 Index (SPY). Since March, 2003 (N = 857 trading days), the correlation of 10 day price moves in EFA and SPY has been .74.

Interestingly, when the U.S. and EAFE are highly correlated on a 10-day basis (.925 or greater; N = 84), the next 10 days in SPY average a gain of .87% (58 up, 26 down). This is stronger than the average 10-day gain of .53% (520 up, 339 down).

Conversely, when the U.S. and EAFE are loosely correlated on a 10-day basis (.50 or less; N = 92), the next ten days in SPY average a gain of only .19% (53 up, 39 down).

When the S&P has risen 2% or more in a 10-day period (N = 186), the next 10 days in SPY have averaged a gain of .41% (112 up, 74 down). When the correlation between the U.S. and EAFE has been above average, however (N = 93), the average 10-day gain has been only .25% (52 up, 41 down). When the correlation between the U.S. and EAFE has been below average (N = 93), the average 10-day gain has been stronger at .58% (60 up, 33 down).

What this suggests is that a world that moves in lockstep may have very different implications for future price change than a world that moves in separate directions. Moreover, this relationship appears to be different under bull and bear conditions. This is an area for fruitful research, I suspect.

About Me

Author of The Psychology of Trading (Wiley, 2003), Enhancing Trader Performance (Wiley, 2006), and The Daily Trading Coach (Wiley, 2009) with an interest in using historical patterns in markets to find a trading edge. I am also interested in performance enhancement among traders, drawing upon research from expert performers in various fields. I took a leave from blogging starting May, 2010 due to my role at a global macro hedge fund. Blogging resumed in February, 2014, along with regular posting to Twitter and StockTwits (@steenbab).